FreeMarkets (85.60)

1937 All Over Again

37

You've heard it from Krugman, on CNBC and from blogs right here on CAPS. "Dealing with deficits now will push our recovery back into recession. It's the wrong thing to do." At least that's what they say, but they've got their history all wrong.

The first problem is there was NO RECOVERY in 1936, unless your definition of recovery is 16.9% unemployment. The second problem is the argument that the government in 1937 pulled back the stimulus too early. This argument fascinates me because the Great Depression was now OVER seven years old. When was this "spend, spend, spend" plan going to work?

We all know Hoover's big mistakes.

1) Smoot-Hawley Tariff Act of June 1930 crippled commerce around the globe.

2) Plowing farmers fields under to increase the cost of food (which was supposed to help farmers with higher prices)

3) Government INACTION! [I find this one most interesting, as if the prior two are not government actions]

But what about this mistake:

1) He spent luck a drunk sailor. To deal with the crash in October 1929, he increased spending by nearly 10% in 1930, by 20% in 1931 and another 15% in 1932. All told, Federal spending increased by 50% in just three years, while revenues dropped.

So what are these people talking about?

Hoover didn't spend money on directly employing people, so his crazy spending is forgotten, especially because FDR spent like a completeley inebriated sailor. The reality and the FACTS are that after seven years of bloated deficit spending, we were WORSE off then when the whole thing began.

Think about the crap reasons we've been spoon fed as to why the Great Depression lasted so long.

1) Our Fed Chairman Bernanke has testified that it was because we let the banks fail. This time, we didn't let the banks fail. So why is the recession still with us?

2) The American people lacked trust in their banks. This time we have the FDIC and no one has lost a penny in the banks. So why is the recession still with us?

3) FDR didn't spend enough. So we doubled deficit spending in 2008, to $407 billion, we then quadrupled it to $2 trillion in 2009 and we're spending that much again this year. So why is the recession still with us?

4) Liquidity trap. That's right, there wasn't enough money in the system because of our stupid gold standard. So we've used the FED to add over $3 trillion of new liquidity. So why is the recession still with us?

SO WHY IS THE RECESSION STILL WITH US?

Lack of bargains. That's right, the great fire sale hasn't happened. Houses at 75% off, factories at 60% off. Everything must go pricing hasn't happened. People and corporations will take their savings and buy bargains, then they'll use those bargains to produce goods and services.

But wait - bargain prices DID happen in the 1930's. The problem was who wanted to buy a factory to sell shirts to Europeans when they were all Tariff crazy.

The continuing problem with DEBT is that people continue to HORDE money as they fear the tax man is coming. The more we spend the greater the American people will fear the coming tax burden and continue to retrench. The gov't will continue a losing battle to compensate by spending more, but with an ever shrinking GDP eventually find itself unable to sustain its spending. That's when the dollar craters and dollars become worthless.

So is FRUGALITY and fiscal discipline our saviour! Yes it is - but not immediately. We need to suffer for one to two years, let the savers come out of their holes and watch the V recovery start.

If the government and the Fed had allowed the market to correct, the recession would be over.

Instead, we have a decade or two of suffering ahead of us, just like the 1930's and just like Japan. We'll handle it better than they did in the 30's, because our labor is more productive. But make no mistake, the Keynesian recovery is a heck of a lot more painful than the free market one.

1) the economy is growing, so the recession isn't with us any longer. We might start a new one, but the old one is gone. The past couple years, to draw from your analogy, were like 33-36. The economy was growing, but had not completely recovered yet.

2) I don't think people are hording money because they are afraid of the taxman. Go poll 50 random people from across the US from both political parties and ask who is saving more out of fear out of fear from rising taxes. I doubt you will get more than 3 yes's.

People are saving because they are afraid for their jobs. With U6 over 15% this is no surprise. They are scared that if they lose their job they won't be able to pay for everything they need, epecially with the end of larger unemployment benefits.

Also it isn't like people are saving gobs of money, they are simply reverting to the historical average for savings: 6-8%

That said I think your Roosevelt Recession comparison is pretty good. It would certainly seem about the right depth and would likely have a similar outcome (minus WW2)

But if everyone were to begin selling assets at fire sale prices wouldn't this cause a vicious spiral of deflation? Businesses eventually become illiquid and are forced to file bankruptcy, unemployment skyrockets consumers spend less, assets depreciate further etc. etc....

MoneyWorksforMe - what you speak of is not possible in the sense that eventually all businesses go bust. Definitely businesses will go bust, but those with capital will buy factories and machinery at very low prices. Then they will put them to work - hiring people for the factory, employees for the machinery. It's similar to watching the market collapse - everyone is selling out of fear, but eventually you hit that bottom, then the V shaped recovery starts.

I very much agree with you analysis and your stance above. Regarding why we bounced in March 2009 (and it was not because it was a compelling bottom, as you point out above) I wrote this post back in April, that I think you might agree with: Moving Some Macroeconomic Deck Chairs: The Dollar, Dollar Swaps, Bonds and LIBOR - http://caps.fool.com/Blogs/moving-some-macroeconomic-deck/369098

That said I think your Roosevelt Recession comparison is pretty good. It would certainly seem about the right depth and would likely have a similar outcome (minus WW2)

Daniel,

Don't discount the possibility of someone doing something incredibly stupid that could plunge us into another great War. If world leaders can keep a cool head with everything teetering from the Mideast to the Korean peninsula we may be OK.